The opening up of the Saudi bourse to foreign investors this week is one of a series of changes that could turn it into a major competitor with the UAE and Qatar for the title of the region's financial centre. The change in regulations, announced on Wednesday by the Capital Market Authority, does not allow foreigners full and direct ownership of shares, but it does give them broad exposure to Saudi equity through agreements known as swaps, or contracts that confer the right to the financial returns and losses from a stock. These swaps must be sold by registered brokers, which are to include Goldman Sachs, Morgan Stanley, Deutsche Bank and other large international banks.
The decision brings the region's largest market - the Tadawul exchange makes up 42 per cent of the market capitalisation of the entire GCC - into the reach of investors who have for years craved exposure to the Saudi market. Many foreign investors are already indirectly buying into the Saudi market, typically by entering into off-the-books swap contracts or investing in mutual funds registered to operate in the country. However, a clear mechanism for exposure to the returns of the Tadawul is welcomed by investors.
"It demonstrates an awareness that this is the long-term direction they need to take," said Imran Ahmed, the managing director of asset management at Mashreqbank in Dubai. "I think the Saudi regulators want to proceed in a cautious manner, tiptoeing in that direction so as to ensure market stability during the deregulation process." Mr Ahmed said that what many outside investors wanted next was for foreign mutual funds and other institutional investors to be allowed to own shares outright in the Saudi market.
Established in the 1930s, the Saudi market is among the oldest in the region, and for much of that time it has been a frustrating nut to crack for outside investors. In the early years, no non-Saudi could trade in or buy shares. Then, in 1997, the government opened the door a fraction: GCC nationals were allowed to invest, but not in banks and insurance companies, two sectors that today make up about 27 per cent of the exchange's market capitalisation. Last August, authorities made shares fully available to GCC nationals.
The beginning of stock-swap trading coincides with a transparency push in Saudi. Just a week ago, regulators began requiring investors with stakes of five per cent or higher to disclose their positions, which caused grumbling among some large shareholders and leading investors. In the long run, however, the hope is that efforts to improve transparency and welcome foreign investors will expand the market, bring in long-term investors and reduce volatility.
There is little doubt that foreigners want in. Publicly listed companies in Saudi comprise more than 42 per cent of the Dh3.8 trillion (US$1.3tn) market value of listed GCC companies. For foreign asset managers who offer GCC investment funds, the inability to get into the Tadawul has been an obstacle. Ingmar Burgardt, the head of the regional office of BHF Bank, a private German bank that has about $600 million invested in the region, said his company was looking into the swaps as a smoother way to invest in Saudi. BHF currently obtains exposure to the market through mutual funds.
"That is not technically the proper way to do the investment because it is a circumvention," Mr Burgardt said. "Under the new system, it's still only via a swap. It's not a 100 per cent direct investment, but you get the full market risk and the full market return." The Saudi market has had a dismal year, falling 23 per cent since January. This, too, has spurred on change, observers say. While the Saudi government is wary of opening up "strategic" companies to foreign ownership, it also recognises that there is strong global interest in Saudi companies, and bringing in more foreign money could buoy up share prices.
M R Raghu, the head of research at Markaz in Kuwait, said the change was in this respect an ideal half-measure. It would revive a moribund Tadawul and prevent foreigners from actually owning Saudi stock. "I don't think they were keen to open up the market fully to foreign investors," he said. "Their interest is in propping up the market, which has gone into the doldrums recently. Using swaps provides economic benefits but without the ownership. I was expecting it, because the top companies are state-owned and the government does not want them in foreign hands. They want foreigners to come in and improve the market, but do not want them to have any ownership."
Others praised the method and the pace that the Capital Market Authority has taken in opening up the Tadawul. Observers expect stocks to gradually open up to foreigners in the next few years on a limited basis, probably under a system like Qatar's or the UAE's. In Qatar, foreigners are restricted to 25 per cent ownership in all stocks. In the UAE, foreigners cannot own controlling stakes, and many companies set more restrictive ownership limits.
Virtually all agree, however, that more open markets are good for all investors, including Saudis, who have for years lived with the volatility of a market driven almost entirely by retail investors and speculators. Pushing these participants to the margins and bringing in large amounts of foreign money will have a stabilising effect, many believe, and could even send the region's largest market to the forefront of the race to represent the Middle East on the global financial stage.
"The key thing is that any meaningful stock exchange has to be open," said Neven Hendricks, the regional managing partner at Deloitte Middle East's financial advisory services. "So when you have exchange controls like in South Africa or Saudi Arabia, giving the investors the authority to enter the market should have an impact on the underlying stock values. "So even though it's going to be through licensed entities, you will have a marketplace where foreigners can hold an interest. It's good for the exchange, since it's down around 23 per cent, and will have a positive effect on liquidity."
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